European Central Bank Hikes Interest Rates For First Time Since 2023

(RTTNews) - The European Central Bank raised its interest rates for the first time in nearly three years in a bid to cushion the impact of rising inflation that is triggered by the surge in energy prices due to the conflict in the Middle East, as the single currency economy struggles to grow.

The Governing Council, led by ECB President Christine Lagarde, hiked the benchmark rate - the deposit rate by 25 basis points to 2.25 percent. The main refinancing rate was lifted to 2.40 percent and the marginal lending rate to 2.65 percent. Such a move was widely expected as policymakers including Lagarde signaled the same since the previous policy session.

"The war in the Middle East is generating inflation pressures, and the decision to raise rates is robust across a range of scenarios mapping out how the shock might evolve and affect the medium-term outlook for the euro area," the ECB said in a statement.

The hike was the first since September 2023, when rates were raised by 25 basis points. With the latest move, the ECB became the first major central bank to lift interest rates in the face of rising inflationary pressures caused by the war in Iran. Recent data showed that Euro area inflation accelerated to 3.2 percent in May, the highest level since 2023, on higher energy prices. Meanwhile, the gross domestic product shrank 0.2 percent sequentially in the first quarter mainly due to a major slump in Ireland, marking the first decline since the final quarter of 2022.

The central bank also revealed the latest round of ECB staff macroeconomic projections for the euro area that saw an upgrade to the inflation forecast and a downgrade to the growth outlook.

The ECB now sees headline inflation to average 3.0 percent this year, 2.3 percent next year and 2.0 percent in 2028. Core inflation that excludes energy and food is forecast at 2.5 percent this year and next, and 2.2 percent in 2028. The bank attributed the upgrade to the view that higher energy prices are expected to feed into food, goods and services inflation to some extent.

Eurozone growth is expected to average 0.8 percent this year, 1.2 percent next year and 1.5 percent in 2028. According to the bank, the downward revision for this year and next reflects a more pronounced impact of the war on commodity markets, real incomes and confidence.

"The outlook remains uncertain, with upside risks for inflation and downside risks for economic growth," the ECB said. The full implications of the war for medium-term inflation and growth will depend on the intensity and duration of the energy price shock, as well as the scale of its indirect and second-round effects."

The ECB staff has also updated illustrative scenarios for a broad range of outcomes for inflation and growth to depict the high uncertainty due to the Middle East conflict.

"With today's decision, the Governing Council remains well positioned to navigate the uncertainty caused by the war," the ECB said. "It will closely monitor the situation and follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance." Policymakers will base their assessment of the macroeconomic outlook in the light of the incoming economic and financial data and will not pre-commit to a particular rate path, the bank reiterated.

ING economist Carsten Brzeski said memories of 2022 - and the acknowledgement that the ECB held on too long to the 'transitory' inflation narrative - are now driving the push for rate hikes.

"This is a kind of insurance rate hike, as the risk of doing nothing and potentially falling behind the curve is larger than the risk of any adverse effects on growth from higher interest rates," Brzeski said.

"In any case, the risk is high that by fighting the ghosts from 2022, the ECB could be gradually repeating its mistakes from 2011," the economist added.